Balance Sheet
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Balance Sheet for a Company
A firm's current balance sheet is as follows:
Assets $100 Debt $10
Equity $90
a. What is the firm's weighted-average cost of capital at various combinations of debt and
equity, given the following information?
Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12%
10% 8% 12%
20% 8% 12%
30% 8% 13%
40% 9% 14%
50% 10% 15%
60% 12% 16%
b. Construct a pro forma balance sheet that indicates the firm's optimal capital structure.
Compare this balance sheet with the firm's current balance sheet. What course of action
should the firm take?
Assets $100 Debt
Equity
c. As a firm initially substitutes debt for equity, what happens to the cost of capital, and why?
d. If a firm uses too much debt financing, why does the cost of capital rise?
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